The word Accrue might pop up several times in conversations related to finance. Most of the remarks that contain this word have a context related to the expenses, incomes and interests for a single business entity or expenses of an individual. For example, a plausible sentence would be, “The interest that you accrued from your last investment.” Hence, meaning, a collection over a certain period. This is also in relation to accrual accounting, which is a globally accepted standard for most companies.
If you have accrued interest or an amount, it means that you stand to receive a collected sum after a certain period is finished. The items that fall under the accrual category are goodwill, accounts payable, accounts receivable, future tax liability, and future interest expense. This method negates the cash accounting method which only records the expenses or revenues where an actual cash transaction has taken place, which does not take credit into account and neglects the tentative liabilities.
How does financial accrue work?
If you have accrued interest or an amount, it means that you are eligible for a collected sum after the completion of a certain period. You should be aware, you cannot only accrue benefits or assets, but liabilities also accrue, like interest accrued on a loan! The term accrue is the same as the word ‘Accrual’ in the GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards).
In these principles, accrual is treated like an adjustment that follows the expenses that are made but not paid, or the revenues that are not yet received. These entries are polar of the entries that show unearned amounts. That means all the other key exchanges in the event have been fulfilled, except the payment, which is yet to be done.
The passable and acceptable entries are confirmed by the FASB (Financial Accounting Standards Board). It is the prime acting body on the interpretations related to the GAAP. The items that fall under the accrual category are goodwill, accounts payable, accounts receivable, future tax liability and future interest expense.
Exceptions of accrue
The accounting related to accrues or accrual accounting in simpler terms accomplishes the objective of tracking or representing the company’s financial position through the recognition of the economic activities irrespective of any cash exchanges. It further depicts a more succinct picture of the business while also showing the company’s financial health in better terms. It leads to the accumulation of assets and liability adjustments for selected periods.
Companies mostly rely on accrual accounting while some emerging entities may use the cash method. It is usually exchanged for the former after the business picks up speed. Financial interpretations are more concise with the use of the accrual method and it often helps the company in creating future plans and strategies too.
Hence, if the company sells $1,000 worth of products/services for credit in February, the accrual method would record $1,000 without waiting for the cash like in the cash method.
A bit more
All financial exchanges usually come under 2 categories. Let’s understand what they mean.
Accrued revenue
Revenue means the income, gains, assets and non-cash transactions included. These revenues are not yet received by the business or the individual. Usually means that the product/service has been sold on credit and the amount will be transferred to them in the future at some point. Accrued revenues account for a major portion of the companies that have frequent credit card transactions.
Let’s suppose that Company A onboards a consulting agency XYZ for a project that is on a 3-month timeline. The fee for the consulting services is $150,000 which is agreed to be paid at the end of the project term. Hence, the company XYZ has an accrued revenue that is to be paid either in installment on milestones or in a lump sum.
Accrued expenses
When there is an expense that is not yet paid, the general ledger is filled with the accrual expense entry. This is also put down in the balance sheet and income statement on the opposite of the income side.
Some instances of accrued income are:
- Salary/wage accruals are accrued when the employer transfers the monthly salary to an employee before the end of the working month.
- Interest expense accruals, which is the company is imposed with interests in advance before they get the invoice for the month.
- Supplier accruals, this expense is incurred when the company gets the goods or services from suppliers but makes the payment on the future date.
Often interest, payments and taxes are also mentioned in accrued entries to represent unpaid entries in the financial statements. Operating expenses can be underestimated or the net income can be overestimated.
There are different logics between various types of accruals expenses. The objective of the accrual account is to support the accounting period respective to them. It is also a good indicator for the prediction for future expenses of the company.
